Small businesses are the heart of any economy since they create most new jobs, provide innovation and dynamism to industry, and add diversity to the marketplace. They tend to be relatively agile and adaptable in a volatile business environment, often pioneering new products and methods. For these reasons, governments of all political persuasions seek to encourage small business formation or expansion.
Despite this generally favourable macroeconomic policy environment, many small businesses fail within their first three years of operation. I am going to examine some of the common causes of such failure – not for the sake of criticism, but rather with a view toward helping entrepreneurs avoid these pitfalls in future ventures. Most new businesses fail simply because they run out of cash; that is no great surprise. Failure can also stem from poor management of existing revenue, lack of sufficient start-up capital, a gap between the owner’s personal expectations and the reality of running a small business, a failure to understand their own target market, no clear plan for growth or expansion, and many more.
I have identified 10 good reasons why small enterprises fail – some more common than others. The list is not comprehensive but rather indicative of patterns that emerge among failed businesses. In any case, if you are an aspiring entrepreneur then taking steps to avoid these mistakes is usually as easy as consulting with those who have been there before. Indeed, part of your early planning process should involve talking with key people in your prospective about what they believe makes a successful venture.
1. Not having a business plan or not sticking to it: The majority of small businesses rely on bank financing, but the banks will generally approve loans only for ventures that demonstrate sound financial planning and budgeting. A good business plan should be your roadmap to success – detailing start-up costs, marketing strategy, sources of revenue, milestones for growth or expansion, and so forth. Without such a plan you are simply floundering in an ocean of possibilities without any sense of direction.
Rather than making last minute changes to your business model or approach based on market conditions (which can send mixed messages to customers), preparation is key; develop your ideas into something concrete that clearly how you intend to make money and sustain an early market advantage.
2. Poor management of existing revenue: Any business needs to maintain a healthy cash flow in order to survive; that is, after all, the lifeblood of any enterprise. If you are unable to keep your revenues in line with expenses then you fall behind on financial commitments and soon find yourself asking for more credit or pushing suppliers for faster payment. Such problems can become irreversible quickly, so it is important to manage your cash flow from the start.
Unfortunately, most small business owners have little training in accounting principles or finance – which leaves them at a distinct disadvantage when it comes to managing their own company’s books. In such cases they should appoint a competent bookkeeper who understands how to interpret data and maintain detailed records of transactions.
3. Lack of sufficient start-up capital: Many business ventures fail due to a lack of either money or management expertise. But perhaps the most common failure is one in which both are present but inadequate for the scale of the venture – that is, insufficient start-up capital. While entrepreneurs are typically hard working and imaginative, many underestimate how much money they will need to get their business off the ground. Who doesn’t want to hold back on expenses during these early stages? The problem is that “lean” budgets can quickly become no budgets at all when you run out of cash without having made significant progress toward revenue generation.
A good rule of thumb with small businesses is that you should plan on about $40,000 for up to six months of operation. This assumes that you have already secured outside investment (from family and friends, a venture capital firm, etc.) or have been able to secure a loan from the bank as discussed above.
4. A gap between their own expectations and reality: It is difficult to maintain perspective when you are so personally committed to your business idea – especially when it has become more than just an idea and is starting to take shape in the form of a small enterprise. Unfortunately, however, this often leads entrepreneurs into thinking that they can do everything themselves with minimal assistance beyond perhaps some part-time staff or consultants here and there. What they soon discover is that running a business requires training and discipline – not to mention a great deal of time and effort that they might not have initially foreseen.
It is important to be realistic about your own strengths and weaknesses, as well as the resources at your disposal, in order to run a successful business venture.
5. Lack of proper technology: One of the biggest threats facing small businesses today is lack of proper technological support; this includes systems for managing projects and accounts receivable, data storage and retrieval, job tracking, inventory management, and so forth. There are many software vendors who offer such systems inexpensively – which can help you manage everything from human resources issues down to accounting functions and tax requirements without ever leaving your office or home computer. These tools can play a major role in the long-term survival of your enterprise.
Entrepreneurs who have a good idea for a business but lack the necessary software often think that they can easily “bootstrap” it – that is, do everything themselves out of a home computer until they are sufficiently profitable to bring on additional staff and buy better tools. The problem with this approach is that you will likely spin your wheels trying to keep up with everything from small details such as sending invoices to larger issues such as bookkeeping. In most cases, those expenses could have been avoided through proper planning and preparation at the start.
6. Failing to manage cash flow: When you consider how much time into running any one aspect of a business, it is amazing that many entrepreneurs fail to track and manage their cash flow. That’s right: you need to pay attention not just to how much money comes in the door, but also how much goes out – and what the net effect will be on your business at any given time. Cash flow management involves keeping track of invoices, bills, payroll expenses, taxes, insurance premiums, rent payments and other ongoing costs as well as monitoring how soon customers are paying their bills (this is a major issue with service businesses) and establishing a budget for your business over a designated period of time to identify potential problems before they become critical.
Without proper cash flow management tools and techniques you run the risk of spending more than your business makes, thus digging yourself into a hole that you will eventually need to get out of.
7. Lack of business knowledge: One of the main reasons entrepreneurs fail is because they lack the necessary business knowledge to run their small enterprise properly; this includes everything from understanding basic accounting principles and concepts to knowing how your industry works – including important information such as what other companies in the field are doing, who your competitors are, etc.
Many new entrepreneurs know just enough about their particular business idea or venture to feel that it’s worth pursuing – but then they never take the time to learn more about it either before or after they open for business. This can lead them astray at some point down the road if not immediately upon starting up.
8. Lack of proper financial backer(s): If you cannot find a prospective financial backer for your new business, don’t expect to open the doors and immediately start making money – unless you have enough personal savings or can get a traditional bank loan (not always easy without collateral, especially if the business idea is still in its infancy).
The skills and resources that you bring to your small enterprise play an important role in its success; however, if you do not know how to run it properly, then these resources will quickly go to waste. It’s one thing to be able to attract investors and another thing entirely for them to stay with your company over time – which they may decide not to do when faced with lackluster profits and revenue.
9. An idea that’s ahead of its time: Many entrepreneurs fail because their enterprise is (or appears to be) ahead of its time, meaning it is less likely to succeed in the current market environment due to a lack of demand from consumers or other factors. Perhaps you have come up with a great new idea for a product or service, but if people are not yet ready or willing to pay money for it then your business will fail regardless of what kind of resources you have.
10. Lack of management experience: Finally, without proper management experience running an enterprise can quickly become overwhelming – even if you have all the best tools at your disposal and a great financial backer(s). This is especially true during difficult economic times such as those we are now experiencing, meaning that small enterprises need to be even more careful than ever before.
The advice and skills you acquire over the years from previous management positions play an important part in how successfully you will run your new business – which means it’s important to seek out relevant training and guidance where possible. After all, what good is a great idea for a company if you don’t have the know-how or skill necessary to make sure it succeeds?